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Over-allocation of emission allowances in the EU

This activity deals with emissions trading in general and the European Union Emissions Trading Scheme (EU ETS) in particular. There is an over-allocation of allowances in the EU ETS, due to the economic crisis and due to industry lobbying. This leads to a low allowance price, weakening investments in low-carbon technology. Various reform measures have recently been adopted that are likely to stimulate such investments, but they will also reduce the cost-effectiveness of the EU ETS in the short term.

The pre-Kyoto phase 2005–2007 of the EU ETS, a learning period prior to the first commitment period of the Kyoto Protocol, was intended to have a gradual start without too stringent emissions caps. Public and private parties could then gain experience with emissions trading and industries subject to international competition and would not face severe competitive disadvantages. Initially, the allowance price rose from € 10 in 2005 to € 30 in 2006, but once it became known how generous allowance allocations had been, the allowance price fell to less than 1 euro in 2007. In the EU as a whole, the number of allowances allocated turned out to be 4 per cent more than actual emissions. This is referred to as allowance ‘over-allocation’ (Ellerman and Buchner, 2008).

EU Member States allocated too many allowances to protect the competitiveness of their own industries, partly in response to national industry lobbying. Although Member States are to blame for handing out too many allowances, no one could have predicted the exact ‘emissions gap’ beforehand, for instance due to incomplete information about the emission levels of companies estimated in advance. Moreover, business growth predictions were overoptimistic and turned out to be lower than expected.

To prevent renewed ‘over-allocation’, the EU decided to distribute the allowances at EU-level based on a single, Community-wide emissions cap for the third trading period 2013–2020. This should prevent Member States from allocating too many allowances to their industries. In principle, the effectiveness of the EU ETS is strengthened when allowances are no longer allocated ‘bottom-up’, but ‘top-down’. Its efficiency similarly improves, since allowance distribution at EU-level is better able to ensure carbon scarcity, thus triggering a positive allowance price, which is necessary to better reflect climate damage. In practice, however, this policy change turned out to be insufficient, since the emissions surplus already amounted to approximately two billion allowances by the start of the third trading phase 2013–2020. About a decade ago, policymakers and traders expected allowance prices of € 25–35 in 2010 and € 35–50 in 2020. At the beginning of the third trading phase, however, the allowance price was around € 5, due to the emissions surplus.

Some stress the advantage of a low allowance price in times of economic recession: it does not weigh heavy on the shoulders of big and small consumers of energy and industrial products. When the economy starts to grow again, the allowance price will increase and consumers will be better able to bear it. Emissions trading, therefore, works ‘countercyclical’: allowance prices increase when economic times are good and decrease when times are bad.

Others emphasise that a low allowance price erodes the development of low-carbon technologies. To improve the orderly functioning of the EU ETS, the European Council has taken three measures. First, the Council approved the so-called ‘back-loading’ proposal of the Commission to postpone the auctioning of 900 million allowances for a number of years (European Commission, 2014). Second, the Council agreed with the Commission to lower the emissions cap for ETS sectors by 2.2 per cent each year from 2021. Third, the Council adopted the Commission proposal to establish a so-called ‘market stability reserve’ (MSR) that reduces the allowance auction volume in case of an allowance surplus (European Council, 2014). If the allowance surplus is ‘big’ in a certain year (more than 833 million allowances), which can only be calculated in the next year, 12 per cent of this surplus will be placed in the reserve by reducing the auction volume with a corresponding amount of allowances in the year thereafter. If the allowance surplus is ‘small’ (less than 400 million allowances), 100 million allowances will be released from the reserve. In May 2015 the Council of Ministers and the European Parliament agreed that the 900 million ‘backloaded’ allowances will be put into the MSR and that this reserve will become operational in 2019 (European Parliament, 2015).